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Forex Intervention – Does It Work? Part II

Forex Intervention – Does It Work? Part II

I wrote an article last year entitled Forex Intervention - Does It Work? at a time when the SNB was facing an uphill battle to contain the rising chf. Click on the link above to see the full text.

Now we face a situation where the market is trying to force the Bank of Japan (BOJ) on orders from the Ministry of Finance (MOF) to intervene by pushing the JPY higher and USDJPY lower to levels not seen in 15 years. While most assume the MOF has been fighting a rear guard battle via covert intervention (for years) using surrogates such as Kampo to slow the JPY’s ascent, the pressures have intensified to the point where it now has to consider more drastic action.

The following is from the article Forex Intervention – Does it Work?

Forex intervention has been going on for as long as I can remember although there is not one set of rules that central banks follow. Rather, forex intervention can be employed in a variety of methods, each having a different level of effectiveness. The recent forex interventions by the Swiss National bank to prevent the CHF from appreciating sparked the idea to write an articleon this subject.

Types of Intervention

1)       Intervention can take the form of being unilateral (i.e. one central acting alone) or coordinated (i.e. various central banks acting in concert).

2) The results of the intervention (i.e. buying or selling a currency) can be sterilized or left un-sterilized. When a central bank sterilizes intervention, it offsets the impact of buying or selling its currency through intervention by adding or draining reserves from its domestic money market. When intervention is left un-sterilized, the central bank allows the full impact of such actions to either increase or reduce the supply of liquidity.

3) The central bank may look for the shock effect by being visible in its forex intervention. This may see the central bank surprise the market and come in via an electronic platform, which gets flashed across wore services. This often sees a sharp reaction in the market but the more times employed, the less impact it tends to have.

4) Other central banks may use surrogates to buy or sell its currency. In this way it can disguise its actions and keep the market guessing. Some call this stealth intervention. There is speculation that the Japan’s MOF (Ministry of Finance) and Bank of Japan employ this tactic but only insiders know whether this is true and if so, to what extent it is used…

Which types of intervention tend to be most effective? As a rule, it is easier for a central bank to intervene to slow the appreciation of its currency than to support a falling currency. Intervention tends to be more effective when accompanied by other measures, such as an increase/decrease in interest rates to make a currency more/less attractive.

Coordinated forex intervention is generally more effective than unilateral intervention in the currency market. The most notable example is the 1986 Plaza Accord, where the G-7 countries agreed to work together to drive down an overvalued USD. It is more difficult for a country, acting alone, to intervene effectively.

Un-sterilized intervention is more effective than sterilized intervention. Traders look to see if central banks sterilize intervention and allow interventions to increase or decrease (as the case may be) the supply of its currency. Most interventions tend to be sterilized as central banks take offsetting measures to limit the impact on domestic monetary conditions.

The more predictable a central; bank is in its interventions, the less the impact each time employed. This is often referred to the law of diminishing returns as the market gets used to it and adjusts its strategies accordingly. The initial reaction to a surprise intervention tends to have the greatest impact. Traders also look to see whether the central bank intervenes at lower/higher levels or gets aggressive by continuing to buy/sell at higher/lower levels. The latter tends to see the most impact but runs a risk as once the central bank steps back, the market tends to reverse some of the earlier moves.

Stealth intervention is more of a gray area. The market only suspects intervention when a central bank uses surrogates to intervene and a lot depends on how much it wants to keep the market guessing. During recent intervention by the Swiss National Bank (SNB), it switched tactics and apparently started placing orders through the BIS (Bank for International Settlements). This fueled speculation that the SNB was behind the BIS bids for EUR/USD and USD/CHF but it was never confirmed. The Bank of
Japan and Ministry of Finance tend to be more secretive but the market suspects they have been employing stealth intervention for years. One reason may be that they did not want to be accused of trying to engineer an undervalued currency. Given Japan
’s dependence on exports, there is suspicion that it tries to limit the JPY upside to help its exporters through stealth intervention, thereby avoiding any criticism from other trading partner countries…

This brings us to the question, Will intervention work? I stated above that as a rule, it is easier for a central bank to intervene to slow the appreciation of its currency than to support a falling currency. This did not prove to be the case this year where the Swiss National Bank (SNB) unilaterally bought massive amounts of EUR/CHF only to find it unable to hold the line and this saw it fall sharply once the central bank was forced out of the market. EUR/CHF set a record low at 1.2988 today and that represented a 12.4% fall from its 1.4820 closing rate for 2009. The lack of coordinated intervention in the face of “real flows” was a factor in the SNB failure.

The BOJ is well aware of the SNB’s experience, where it not only was taken out by the market but suffered huge losses on reserves accumulated via intervention. However, the decision whether to intervene will be a political,one and the BOJ will be asked to carry it out. The market, meanwhile, is also well aware of the SNB experience and will likely act similarly should intervention take place in USD/JPY. Assuming this is not a coordinated effort to contain the JPY, unilateral intervention will have a diminished impact the more times it is used. I call this the law of diminishing returns.

In the meantime, expect caution as Japanese officials try to jawbone the market via verbal intervention. The market is responding by seeking the path of least resistance by pushing the JPY higher, such as via its crosses, which would be less likely to spark an intervention response. This also makes the market less short USD/JPY than otherwise might be the case as no one wants to get caught in the first wave of intervention. Should the MOF decide to authorize intervention, expect the market to play a cat and mouse game but look to fade intervention spikes the more times it is employed.


Jay Meisler is a co-founder of, the leading forex discussion site for more than a decade and where traders from around the globe come for the latest breaking news, flows, rumors and trading ideas. =>



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